The Onus of Bonus

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Ask CFOs to draw a picture of themselves when they are calculating incentive compensation and they inevitably draw an angry, two-headed monster with red question marks shooting out of their mouths like flames.

Or offer words to that effect. Along with marketing spend, the payment of commissions and bonuses is the absolute bane of corporate finance chiefs. Typically, finance managers rely either on spreadsheets or jerry-built applications to oversee variable comp. It’s a tricky business. In a number of industries (such as publishing), a commission is sometimes paid on a sale before the income from the sale is actually booked. In others (software, for one) a commission is often parsed out based on the recognition of revenue — no small task if goods and services are bundled. No wonder analysts estimate that 4 to 6 percent of incentive comp doled out by businesses is wrong.

Mistakes can prove disastrous, too. Last year, software publisher CA was forced to restate 2006 earnings in part because of problems with its incentive-comp program. Apparently, management at CA spent $70 million more in commissions for its 2,500-person sales force than it had expected.

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Stories like that — along with the internal-controls pressures wrought by Sarbanes-Oxley — have more CFOs checking out software aimed at automating the process. There’s no shortage of applications to choose from. Marquee players like Oracle and SAP sell incentive-comp management programs. So do smaller software vendors, including Callidus, Synygy, Xactly, Centive, Varicent, and Halogen. ICM programs vary by feature set and robustness, but all promise to streamline and simplify the administration of incentive-comp plans.

Michael Dunne, a Gartner Group research vice president, says some companies that have implemented ICM systems have reduced their error rates from 10 percent to less than 1 percent. And the adoption of these programs is just starting to pick up. Gartner reckons that 1 percent of large companies operated ICM software in 2001. By 2006, that figure had climbed to 5 percent. Analyst Denis Pombriant of Beagle Research believes that businesses are just beginning to look at how they administer their variable compensation plans. Says Pombriant: “We’re at the classic beginning of a market phase.”

Incents and Peppermints

Undoubtedly, some CFOs will be attracted by the notion of easing the scut work that incentive pay schemes generate. But some finance chiefs may see strategic value in the programs. According to a survey of companies conducted by Aberdeen Group, more than three-quarters of the respondents said incentive-comp plans are fueled by the need to align worker behavior and performance with business goals.

Achieving those goals can be elusive. One complication: scores of companies pay commissions to third parties such as product resellers and insurance agents. Calculating the complex variable payments on those sorts of out-of-house and team-based sales — which are usually tied to quota-, territory-, and product-driven commissions — can trigger an intervention by the MIT physics department.

Consider the case of Carl Zeiss MicroImaging Inc. The Thornwood, New York–based distributor sells a dizzying array of scientific instruments, ranging from $1,100 microscopes to $700,000 advanced imaging systems. The company maintains a worldwide sales, administrative, and services staff of 210. Up to 70 percent of the pay for the sales personnel is variable. What’s more, the company employs team-based sales, and some specialists work on several teams.

That’s complex enough. But four years ago, company management decided it needed to reward salespeople for selling specific instruments. Until then, team members had been compensated based on the dollar volume of sales alone. Not surprisingly, that setup had sales staffers hawking the most expensive products and disregarding smaller-ticket items.

Philip Gottlieb, vice president of finance at Carl Zeiss MicroImaging, says it would have been impossible to rework the company’s sales strategy without better compensation software. Zeiss’s existing program was a proprietary mainframe application that required a programmer to make even the simplest adjustment, such as adding a new hire. “If the market changed or our strategy changed midyear, we’d find ourselves sitting around a table saying, ‘We can’t implement that in a comp plan,'” recalls Gottlieb. “It was trying to turn an elephant with a flyswatter.”

The company’s new ICM program, from Synygy, has sped up commission reporting. In addition, the finance department can make an ad hoc change — for instance, adding a promotional incentive — in a day or two. Errors are also way down. Equally important to Gottlieb, the system now rewards salespeople for instruments sold as well as dollar volume. In fact, sales staffers can use the software to run what-if scenarios that forecast commissions on specific deals. “The behavior [of the sales force] has changed,” says Gottlieb. “They understand now what they need to do to optimize their commissions.”

Long Time Loading

Success stories have not galvanized the market, however. A recent survey conducted by Aberdeen did reveal that best-in-class companies are three times more likely to be using ICM software than “normal” or “laggard” companies. But Aberdeen also found that less than 10 percent of the surveyed companies have actually installed ICM systems. Moreover, only about one in four reported that they planned to do so.

The hang-up? Mostly the considerable time and effort it takes to change a corporate compensation plan. The prospect of a lengthy software rollout only adds to the fear factor. Beyond the actual loading of software and scrubbing of data, it takes time for employees to get comfortable with new applications and new ways of doing things. Network Appliance purchased an ICM system some seven years ago. Gerry Rice, worldwide field-operations controller and vice president of finance at NetApp, says it was a difficult transition — one that, in fact, is still ongoing. “The usage of the tool has evolved from basics to a more sophisticated [approach] in applying variables and measurements,” notes Rice. “We continue to make improvements in our usage of the full functionality of the program,” she adds.

To ease customer concerns about endless deployments, some ICM vendors deliver the software as a service. Xactly, Centive, Varicent, and Halogen host their applications on their own servers, providing customers with Web-based access for a monthly charge. That fee ranges from $10 to $50 per month per user (in some cases, volume discounts shrink the price). More-established vendors, including Callidus, also offer software-as-a-service models.

The approach makes sense for small to midsize businesses. Jim Fowler, CEO of Jigsaw Data Inc., an online business-card trading service, says he is only now contemplating purchasing software to oversee the variable compensation of the company’s 20 or so salespeople. “We’re just getting large enough to think about it,” he says. “[Until now] we’ve done it the old-fashioned way, with spreadsheets.”

With variable compensation getting more complicated by the day — and with managers keen to exert more control over sales — spreadsheets won’t cut it for much longer. “The [ICM] software allows us to assign and measure goals that directly tie to the company’s objectives,” says NetApps’s Rice. “And it provides predictability for these expenses.”

When it comes to incentive comp, a little predictability is a very good thing. Just ask the folks at CA.

Elaine Appleton Grant writes frequently about business software.

Now Go Sell!Reasons businesses deploy incentive-compensation schemes*

76%

Align worker behavior and performance with business goals

47%

Increase revenue and profit

38%

Retain nonsales employees

*Multiple responses allowed. Source: Aberdeen Group

You Oughta Be on YouTube

Daughtry and Bon Jovi aren’t the only outfits promoting hip new videos these days. In an odd twist on financial reporting, a handful of companies are imploring shareholders to check out their videos.

Management at marquee businesses such as Sealy Corp. and Ruth’s Chris Steak House Inc. are actively flogging short movies known as video annual reports. The digitized clips, which run anywhere from four to six minutes, play up a company’s financial strengths and market strategies.

The Hollywood approach isn’t just about image, however: a graphics-intense annual report can ultimately cost a large-cap company $1 million to produce and mail. A video report, in contrast, may run $20,000.

The embrace of video is part of a larger movement away from printed shareholder communications, a trend the Securities and Exchange Commission heartily endorses. In fact, the SEC has taken several steps to streamline the delivery of all proxy-related materials. In December, the commission tentatively approved a plan to allow Web-only versions of Schedule 14A proxy statements, Schedule 14C information statements, and annual reports to suffice. That would be a major step forward from the current system, in which beneficial shareholders can request digital delivery of proxy items in lieu of printed matter, an option many choose not to take: during the 2005 U.S. proxy season, Automatic Data Processing mailed about 90 million paper proxy items to beneficial shareholders.

The SEC’s proposal, which takes effect on a voluntary basis this month, will ease that paper jam by making Internet delivery the de facto setting. Admittedly, the bulk of the savings will come from reducing printing and mailing costs, not from ditching the graphics-intense introductory material found in a typical annual report. Still, companies that have produced videos say the appeal goes beyond economics. Susan Collyns, CFO of California Pizza Kitchen, estimates that the $550 million company will save a mere $20,000 by eliminating hard copies of annual reports, but says the video is simply “a better method of communication.”

Certainly, these video reports — typically found on a company’s Investor Relations home page — offer a more intimate portrait of a business. J. Mitchell Collins, CFO at Equity Inns, believes the hotel real estate investment trust’s digitized annual report gives investors a much better sense of the folks who are actually running the company. “When you read an annual with a letter from the chairman, it doesn’t personify the whole management team,” explains Collins. “But with the video, you get to meet our entire group in six minutes.”

“People want to hear management talk about their business,” says Thomas Pennison Jr., CFO of Ruth’s Chris Steak House. “Frankly, the opportunity to do that in front of most investors is limited.” And unlike printed annuals, video annuals can be updated throughout the year and can be played for a range of audiences, including prospective employees. Collyns of California Pizza Kitchen even played that company’s video for the audit committee, and says it also serves as a useful piece of collateral marketing. By comparison, says Pennison, “a printed annual often goes on a shelf, never to be looked at again.”

Video annual reports are not without their drawbacks, however. Viewing a clip can be slow, depending on your connection speed and quality. And a would-be viewer may have to change the computer’s default video player, or download a new one. As for the videos themselves, while they do put a human face (many, in fact) on a company, they can also smack of late-night infomercials, with the company served up like a rotisserie chicken. You almost expect the CEO to say, “Supplies are limited!” as an 800-number flashes on the screen. In the four videos reviewed by CFO, not one mentioned real-world risks like market downturns or pension obligations.

Then again, companies don’t lead with that material in their printed annual reports either, and video annual reports are meant to augment, not replace, the charts, footnotes, and disclosures that can be found in Web-based documentation.

Some CFOs seem sold on the idea. Videos are “effective, clean, and cutting-edge,” Collins says. In fact, video seems poised to alter many forms of corporate communications; companies report that job candidates are now applying via DVD-based video résumés. With an entire generation now being weaned on Web-based video sites such as YouTube, future investors will undoubtedly embrace video over print. “In five years,” predicts Tom Ryan, CEO of corporate-relations firm ICR, “a printed annual report will be a collector’s item.”